November 15, 2007

Bank write it over?

Last quarter was a disaster for the financials. So far the amount of write down charges totaled $43 billion (total write downs for money centre banks and brokerage companies).

Although there was no disclosure regarding the details of the assets written down (when it was originated...etc), I bet that those assets were originated in 2007 and banks could not unload them to investors before the credit crunch took place and they remain on their books.

Take a look at the following schedule from The schedule represent price index of various Asset Backed Securities (ABS) with their rating (Index ABX-HE-AAA 07-2 means a triple AAA rated paper originated in February 2007). The most important part of the schedule is origination date. All indexes with series 7 means it originated in 2007 while 6 means it was originated in 2006. Note the price difference for the index, for the same credit rating; the market pricing is holding relatively well for 2006 assets compared to 2007. ABS suffered huge losses in some cases more than 70% of value, while 2007 losses were relatively small. I am concluding that most write downs in the quarter were from the variety of 2007 assets not from previous years ABS.

This poses a potential hazard if the economy retreats more. If the economy and housing market continues to deteriorate we should expect more write downs to appear on the books of hedge funds, banks and brokerage. Assets originated in 2006 will suffer defaults and losses and banks will have to write down more assets. Why should 2006 ABS be any different? The only difference is 2006 assets still have value in their homes from price appreciation, so home owners can refinance some and keep up with payments. However, if home prices continues to decline more expect that home owners to have more defaults and 2006 assets to decline in value and more write downs are needed.

No comments: